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Value-BasedMarketing

Marketing Strategies for CorporateGrowth and Shareholder Value

Peter Doyle

A John Wiley and Sons, Ltd., Publication

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Marketing Strategies for CorporateGrowth and Shareholder Value

Peter Doyle

A John Wiley and Sons, Ltd., Publication

Second edition copyright 2008 by John Wiley & Sons, LtdThe Atrium, Southern GateChichester, West Sussex PO19 8SQEngland

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Original edition published by John Wiley & Sons Ltd in 2000. This edition updated for John Wiley & Sons Ltd by Laura Mazurwith the permission of Sylvia Doyle and with the agreement of an expert Advisory Board.

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Library of Congress Cataloging-in-Publication Data

Doyle, Peter, 1943 June 23-2003Value-based marketing : marketing strategies for corporate growth and shareholder value / Peter Doyle. – 2nd ed.

p. cm.Includes bibliographical references and index.ISBN 978-0-470-77314-7 (cloth)

1. Marketing–Management. 2. Corporations–Valuation. I. Title.HF5415.13.D59 2008658.8–dc22

2008032150

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

ISBN 978-0-470-77314-7

Typeset in 9.5/13pt Gill Sans Light by Laserwords Private Limited, Chennai, IndiaPrinted and bound in Great Britain by Scotprint, Haddington, Scotland

www.wiley.com

Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii

PART IPrinciples of Value Creation

1 Marketing and Shareholder Value . . . . . . . . . . . . . . . 3Introduction and objectivesManaging in the twenty-first centuryMeasuring success: shareholder valueMarketing’s lost influenceMarketing’s new opportunityThe shareholder value principleChallenges to shareholder valueAccounting-based performance measuresThe changing role of marketingSummary

2 The Shareholder Value Approach . . . . . . . . . . . . . . . 36Introduction and objectivesPrinciples of valuationShareholder valueEconomic value addedFinancial value driversMarketing value driversOrganisational value driversMarketing applications of shareholder valueLimitations of shareholder value analysisSummary

3 The Marketing Value Driver . . . . . . . . . . . . . . . . . . . . . 73Introduction and objectivesA new definition of marketingCreating customer valueBuilding the differential advantageBuilding relationships with customersImplementing relationship marketing

vi CONTENTS

Organisational requirementsThe customer-focused organisationSummary

4 The Growth Imperative . . . . . . . . . . . . . . . . . . . . . . . . . . 105Introduction and objectivesMarketing, growth and shareholder valuePathways to growthDeveloping a growth strategySummary

PART IIDeveloping High-Value Strategies

5 Strategic Position Assessment . . . . . . . . . . . . . . . . . . . 151Introduction and objectivesAn overviewAssessing the current positionExplaining the current positionProjecting the future of the businessImplications of the strategic position assessmentThe value-based planStrategic objectivesSummary

6 Value-Based Marketing Strategy . . . . . . . . . . . . . . . . 189Introduction and objectivesWhy strategic marketing plans?Corporate level planningBusiness unit planningThe planning processSummary

PART IIIImplementing High-Value Strategies

7 Building Brands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227Introduction and objectivesThe role of intangible assetsThe role of the brandBrands and shareholder valueHow to build brandsIssues in brandingOrganising the brand portfolio

CONTENTS vii

Valuing the brandSummary

8 Pricing for Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262Introduction and objectivesPrice and shareholder valuePricing principlesSetting the priceAdapting prices to customers and productsChanging the pricePrice managementSummary

9 Value-Based Communications . . . . . . . . . . . . . . . . . . . 300Introduction and objectivesCommunications and shareholder valueCommunications and customersDeveloping a communications strategyAllocating across communications channelsValuing communications strategiesSummary

10 Value-Based Marketing in the Digital Age. . . . . . 325Introduction and objectivesThe growth and development of the InternetDrivers of change in the new economyCreating value through the webImplications for marketing strategyBuilding the brand on the InternetFuture perspectivesSummary

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350

The Advisory Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351

Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355

Preface

This book is aimed at senior management – marketing, finance, operations managers, and indeed all those withresponsibility for the economic performance of their businesses. It is also intended for use on advanced marketingcourses on MBA and similar level management programmes.

THE OBJECTIVES

The goals of the book are ambitious – they are no less than to redefine the purpose of marketing and how its contri-bution should be measured. The result of this redefinition is a concept of marketing that is more practical and morerelevant to the objectives of today’s top management. Specifically, it is argued that the purpose of marketing is to con-tribute to maximising shareholder value and that marketing strategies must be evaluated in terms of how much valuethey create for investors. This concept, which is called value-based marketing, does not overthrow the existing bodyof marketing knowledge. On the contrary, it makes it more relevant and practical by giving it greater clarity and focus.

Many senior managers have noticed a paradox in how firms perceive marketing. On the one hand, every chiefexecutive and mission statement puts marketing at the very top of the agenda. Getting closer to customers andmeeting their needs is seen as the cornerstone of building a world-class company. A market orientation is regardedas the essential coordinating focus for all the disciplines and processes of the business. At the same time, marketingprofessionals, marketing departments and marketing education are not highly regarded. Few chief executives arefrom a marketing background, most companies do not have a marketing director on the board, and marketingqualifications are often not treated seriously. One leading consulting firm has called marketing departments ‘amillstone around an organisation’s neck’.

What accounts for this paradox of marketing being paramount but market professionals being disregarded? Themain problem is that the marketing discipline has rarely been clear what its objectives are. Most strategy proposalsemanating from marketing staff justify investments in advertising or marketing, in terms of increasing consumerawareness, sales volume or market share. But most boards of directors are sceptical that such measures have anyclear relation to the firm’s long-run profitability. Marketing managers rarely see the necessity of linking marketingspending to the financial value of the business. Given today’s enormous pressures on top managers to generatehigher returns to shareholders, it is hardly surprising that the voice of marketing gets disregarded. The situation willnever be resolved until marketing professionals learn to justify marketing strategies in relevant financial terms.

If managers can show that marketing will increase returns to shareholders, marketing will obtain a much morepreeminent role in the board rooms of industry. The discipline itself will also obtain more respect for its greaterrigour and direction. The purpose of this book is to demonstrate how marketing creates value for shareholdersand to provide managers with the practical tools for developing and evaluating marketing strategies using modernshareholder value analysis.

MARKETING AND SHAREHOLDER VALUE

That the central task of management is to maximise shareholder value has for some time been virtually unanimouslyaccepted by top managers in the USA and the UK, and increasingly in continental Europe and Asia. Shareholder

x PREFACE

returns grow when a company increases its dividends or when its share price rises. Outside top management, theidea of running a business to maximise shareholder value remains controversial. But today’s managers know thatunless they do this, their jobs will become vulnerable, the business will be put at risk and new capital will be difficult toobtain. In competitive capital markets, earning returns that shareholders regard as acceptable is a necessity for survival.

Much of the controversy surrounding maximising shareholder returns occurs because the concept is misunderstood.It is most misunderstood among managers. Managers confuse maximising shareholder value with maximising profits.The two are completely different. Maximising profits is about short-term management: cutting costs, reducinginvestment and downsizing. It is totally antithetical to developing long-term marketing strategies and buildingworld-class businesses. By contrast, shareholder value is a long-term concept; it is about building businesses that last.Despite what managers believe, investors see through short-term tactics that temporarily boost profits. Often shareprices actually fall when companies announce cuts in spending on marketing and less ambitious long-term goals.

Value-based marketing is founded on shareholder value analysis – a well-accepted body of financial theory andset of techniques. Shareholder value analysis states that the value of a business is increased when managers makedecisions that increase the discounted value of all future cash flows. We show in this book that shareholder valueoffers enormous opportunities to marketing. First, it enables the purpose of marketing in commercial firms to beclearly defined. Its purpose is to build intangible assets that increase shareholder returns. Second, it explains howmarketing strategies need to be evaluated: they are worth pursuing if they increase the net present value of thefirm’s long-term cash flow. Third, rigorously exploring the effects on shareholder value makes it harder for boardsto make arbitrary cuts in marketing budgets and similar measures to boost short-term earnings.

The most important contribution of value-based marketing is to make the shareholder value concept more useful.While more and more chief executives are espousing that their job is to maximise shareholder value, all too often it hasbecome associated with cutting costs and downsizing. In many companies shareholder value has become an account-ing tool rather than a general management concept. What many executives have not understood is that shareholdervalue is more about growth and grasping new market opportunities than reducing expenses. All the companies thathave created the greatest value for shareholders in the past decade – Nokia, GE, Cisco and Procter & Gamble – havebeen market-led, high-growth companies. As we show in the book, creating shareholder value is really about iden-tifying emerging opportunities, putting together marketing strategies that can enable firms to rapidly obtain criticalmass, and building lasting relationships with customers. Shareholder value is not built in accounting departments.

THE STRUCTURE OF THE BOOK

The book is in three parts. Part 1 presents the principles of value creation. The first chapter explains thecurrent weaknesses of professional marketing and why its contribution to business performance is disappointing.Chapter 2 presents the theory of shareholder value and shows how these financial principles relate to marketingstrategy. Chapter 3 shows why marketing is the principal driver of financial value. Chapter 4 explores why growth isso important to creating shareholder value and how managers can organise to accelerate growth. Part 2 focuses onhow to develop strategies that lead to value-creating growth. Chapter 5 explains how to assess the current positionof the business and its prospects. Chapter 6 leads on to developing value-based marketing strategies for current andnew businesses.

The final part of the book examines how to implement these new high-value strategies. Chapter 7 looks atintangible assets and the role of the brand in building shareholder value. Chapter 8 re-examines pricing from a value

PREFACE xi

perspective and shows how the current theory of pricing often leads to decisions that are too short-term in theirorientation. Chapter 9 explores the role of advertising and marketing investments in creating long-term value andhow to decide on how much should be spent. The final chapter looks at the implications of the digital age onvalue-based marketing.

Readers will quickly become aware that this is not a ‘one-minute manager’ type book. It is a rigorous presentationof some of the most challenging ideas in modern management. It asks the reader to grapple and integrate currentwork not just from marketing, but also from finance, economics, strategy and information systems. The text is fullyreferenced with the most influential research and papers. The ideas in this book are so important that it is hoped thereader will feel the challenge is worth taking up. Managers need to be technically accomplished if they are to contributeeffectively to the development of their businesses in our rapidly changing world. The aim has been to write this bookin a readable style and to include many examples to keep it highly practical and close to the issues in the real world.

This is the second edition of this book. The ideas are still fresh and the analysis still rigorous. The only changes madehave been to update case studies where relevant and add new references. It has been done with the guidance ofan expert advisory board of acclaimed academics overseeing the editing and updating of the text.

The Advisory Board

Tim Ambler, Senior Fellow, London Business School

Michael J. Baker, Professor Emeritus, Strathclyde Business School

Tony Cram, Programme Director for Business Strategy and Market Innovation, Ashridge Business School

Susan Hart, Dean of Strathclyde Business School

Jean-Claude Larréché, holder of the Alfred H. Heineken Chair at INSEAD

Malcolm McDonald, Emeritus Professor, Cranfield University School of Management and Honorary Professor atWarwick Business School

John Saunders, Professor of Marketing, Aston Business School

Veronica Wong, Professor of Marketing and Director of the Diversity, Knowledge and Innovation ResearchProgramme at Aston Business School

The Editor

Laura Mazur

ACKNOWLEDGEMENTS

Many people have influenced this book. During my fifteen happy years at the University of Warwick I have benefitedfrom the ideas of many of my colleagues including John McGee, Andrew Pettigrew, John Saunders, Howard Thomas

xii PREFACE

and Robin Wensley. At the London Business School I learned from the wisdom of Andrew Ehrenberg and KenSimmonds. At INSEAD I worked fruitfully with Jean-Claude Larréché and Marcel Corstjens. At Stanford University Iwas impressed by the work of my colleagues David Montgomery and V. Srinivasan. At Bradford University I workedwith Dave Cook, Ian Fenwick, Graham Hooley, Davis Jobber, Jim Lynch and Paul Michelle. My initial interest inmarketing models was stimulated during my PhD studies at Carnegie-Mellon University, where I benefited from thesupervision of Richard Cyert and the teaching of Nobel laureates Herbert Simon and Robert Lucas.

Most of all, the book reflects what I have learned from my consulting work. In particular, the book is influenced bythe cooperation of managers from the following client organisations:

3M Dixons OgilvyAccenture Hewlett Packard PhilipsAstraZeneca IBM PricewaterhouseCoopersBritish Airways ICI Saatchi & SaatchiBMP DDB Omnicom Johnson & Johnson SafewayBP-Amoco J. Walter Thompson ShellBritish Telecom KPMG TescoCabinet Office Marks & Spencer UnileverCadbury-Schweppes Mars Wal-MartCoca-Cola Nestlé WH Smith

Novartis Woolworths

Finally, my deepest thanks are to my wife Sylvia and our sons, Ben and Hugo, who provided me with the supportand encouragement to complete this book.

About the author

Peter Doyle was internationally recognisedfor his teaching and research on marketingand business strategy. He was Professor of Marketingand Strategic Management at the Universityof Warwick Business School. Previously he heldpositions at the London Business School, INSEAD,Bradford University and Stanford University.

He was the author of numerouspapers which have appeared in most of the world’stop journals, including the Journal of Marketing, Journalof Marketing Research, Management Science and theEconomic Journal. His other books include MarketingManagement and Strategy (Prentice Hall) andInnovation in Marketing (Butterworth-Heinemann).

He acted as a consultant to many of the most famous international companies including Coca-Cola, IBM, Nestlé,Cadbury-Schweppes, British Airways, Mars, Johnson & Johnson, Unilever, Shell, BP Amoco, AstraZeneca, Novartis,3M, Saatchi & Saatchi and Wal-Mart. He also advised such professional bodies as Britain’s Cabinet Office, theInstitute of Chartered Accountants, the Institute of Directors, the CBI, the Pacific-Asian Management Institute andthe Singapore Department of Trade.

Peter Doyle ran executive programmes for senior managers throughout Europe, the United States, South America,Australia and the Far East. He had been voted ‘Outstanding Teacher’ on numerous university and corporatecourses. He had a First Class Honours degree from the University of Manchester and an MBA and PhD fromCarnegie-Mellon University, United States. His research twice led him to be awarded the President’s Medal of theOperational Research Society and the Best Paper Award of the American Marketing Association.

On reading this book, distinguished international marketing academic Philip Kotler – considered the founding fatherof marketing – predicted that it was destined to ‘spark a revolution in marketing’. This seminal book has indeedpersuaded marketers to think differently about the importance of shareholder value and marketing’s central role increating it. Even more importantly, it offers them the tools with which to do it.

Peter Doyle was born on 23 June 1943. His untimely death occurred 30 March 2003. He is sadly missed by family,friends and colleagues. He is survived by his wife Sylvia and his sons Ben and Hugo.

PART 1PART 1Principles of Value Creation

1. Marketing and Shareholder Value

2. The Shareholder Value Approach

3. The Marketing Value Driver

4. The Growth Imperative

1Marketing andShareholder Value‘If you are not willing to own a stock for 10 years don’t even think about it for 10 minutes.’

Warren Buffett, Berkshire Hathaway Annual Report

INTRODUCTION AND OBJECTIVES

In recent years creating shareholder value has become the overarching goal for the chief executives of more andmore major companies. As we shall see, both theoretically and empirically the case for managers choosing strategiesthat maximise shareholder value is almost unchallengeable. Those companies which have achieved this suggest thatthere should be no conflict between marketing and shareholder value.

The illusion of conflict has occurred because many managers have confused maximising shareholder value andmaximising profitability. The two are completely different. Maximising profitability is short-term and invariably erodesa company’s long-term market competitiveness. It is about cutting costs and shedding assets to produce quickimprovements in earnings. By neglecting new market opportunities and failing to invest, such strategies destroyrather than create economic value. Strategies aimed at maximising shareholder value are different. They focus onidentifying growth opportunities and building competitive advantage. They punish short-term strategies that destroyassets and fail to capitalise on the company’s core capabilities.

By the time you have completed this chapter, you will be able to:

❍ Describe the new marketing challenges faced by today’s managers

❍ Understand the central role of shareholder value

❍ Assess why marketing has too little influence in the board room

❍ Recognise why marketing is the bedrock of shareholder value analysis

❍ Identify how the profession and discipline of marketing need to change to make it more relevant to topmanagement

The next section discusses the striking new challenges of the information age: global markets, changing industrialstructures, the information revolution and rising consumer expectations. It is shown how these changes havefar-reaching implications for the strategies and organisations of all businesses. This leads to a discussion of theshareholder value concept and the market-to-book ratio as measures of the success of a business.

A major problem for marketing is that it has not been integrated with the modern concept of financial value creation.This has handicapped the ability of marketing managers to contribute to top management decision-making. Yet

4 MARKETING AND SHAREHOLDER VALUE

marketing-led growth is at the heart of value creation. Without effective marketing, the shareholder value conceptbecomes little more than another destructive technique gearing management to rationalisation and short-termprofits. Value-based marketing is presented as a new approach, which integrates marketing directly into the processof creating value for shareholders and thereby for all stakeholders. Value-based marketing makes the shareholderconcept more valuable and marketing more effective.

MANAGING IN THE TWENTY-FIRST CENTURY

The enormous changes in the global market environment explain today’s pressures for greater managementeffectiveness. Competitive capitalism is Darwinian in nature. Businesses succeed when they meet the wants ofcustomers more effectively than their competitors. Corporate profitability depends primarily on the company’sability to offer products and services which customers choose to pay for. But what products and services customersregard as attractive is a function of the market environment. What is an appealing computer, retail store or bankingservice today will not be tomorrow. Technological change, new competition and changing wants make yesterday’ssolutions obsolete and create the opportunity for new answers.

The result is that most companies do not usually last very long. De Geus calculated that the average life expectancyof a Western company is well below 20 years.[1] The period over which a successful firm can maintain a profitablecompetitive advantage is usually even shorter. Normally any innovation in product, services or processes is quicklycopied and the surplus profit is competed away. Even where a company endures and grows, its true profitabilitynormally erodes. Studies show that the average company does not maintain a return above its cost of capital formore than seven or eight years.[2]

While the period over which the average business is successful is short, there are companies that do better. Thereare a few examples of companies that have survived and maintained successful economic performance over amuch longer period. Currently examples would include GE, Coca-Cola, Nike and Hewlett-Packard. But quotingexamples of excellent companies is a hazardous venture. Great companies have a tendency to go belly-up whenthe environment changes fundamentally. Few leaders have the perspicacity, courage or capabilities to overturn thestrategies, systems and organisation which created their past achievement.

ENVIRONMENTAL CHANGE

Environmental changes affecting the performance of the business can be categorised as macro or micro. Macroenviron-mental changes are the broad outside forces affecting all markets. These include the major economic, demographic,political, technological and cultural developments taking place today. The microenvironment refers to the specificdevelopments affecting the firm’s individual industry: its customers, competitors and suppliers. These developmentsreflect the impacts of the macroenvironmental changes on the specific industry (Figure 1.1).

Today this macroenvironment is experiencing unique historical changes which are fundamentally redrawing thebusiness and social landscape. These changes have been given various names including the ‘post-industrial society’,the ‘global village’, the ‘third wave’ and perhaps most accurately the ‘information age’.

Social scientists describe three periods of economic evolution in the Western world: the agricultural era, which lastedfrom around 8000 BC to the mid-eighteenth century; the industrial era, which lasted until the late twentieth century;

MANAGING IN THE TWENTY-FIRST CENTURY 5

Globaleconomy

Demographics

Naturalenvironment

Social-culturalThe macro-environment

The microenvironment

Technology

• customers• competitors• suppliers

Political-legal

Figure 1.1 The Business Environment

and finally what we will call the information age, which began in the 1960s and will last for decades to come.[3] Thesedates are of course approximate and overlapping. The first era was based on agriculture, with physical labour beingthe driver of any wealth that was achieved. This eventually gave way to the second era sparked by the industrialrevolution, when machinery replaced muscle power, and factories replaced agriculture as the dominant employer,leading to an enormous growth in both agricultural and industrial productivity.

While the agricultural era lasted for over two thousand years, the industrial age lasted only two hundred. The1960s began to see the end of the industrial era and the beginning of the new information age. Employment inmanufacturing began to drop in all the advanced countries and the service sector became the new focus for growth.Blue-collar workers who operated equipment in crowded factories were increasingly replaced by white-collarworkers working individually or in small teams using computers and scientific knowledge in office environments.Today, information technology has replaced factories and machine power as the source of productivity growth andcompetitiveness.

The transitional periods between the three great waves of change have not been smooth. In Figure 1.2 each waveis represented by an ‘S’ curve that shows an early period of turbulence, followed by a long spell of maturity, andthen its eventual demise as new technologies take over. The last decades of the twentieth century witnessed theperiod of turbulence marking the birth of the information age and the death of the industrial era. The turbulenceincluded record levels of mergers and acquisitions, the collapse of communism in the former USSR and its satellites,and economic crises in South East Asia. All these reflected old second-wave industries and social organisations beingpushed aside in the competitive environment of the new information age.

Four aspects in particular of the new information age require fundamental strategic and organisational responsesfrom management:

1. The globalisation of markets2. Changing industrial structures


Liv

ing

stan

dard

s

Periods of turbulence

Agricultural age8000 BC – 1750

Industrial age1750 – 1960

Time

Information age1960 – ?

Figure 1.2 The Three Waves of Economic Change

3. The information revolution4. Rising customer expectations

THE GLOBALISATION OF MARKETS

The new information age has seen a dramatic shift to global markets and competition. Across more and moreindustries, firms that are not building global operations and marketing capabilities are losing out. Recent decades haveseen an enormous growth of international trade in goods, services and capital. The General Agreement on Tariffs andTrade (GATT) and its successor organisation the World Trade Organization (WTO) have been the means of nego-tiating a general lowering of barriers to trade between countries and an opening up of markets. The stimulus to thisliberalisation of trade has been experience. Governments have seen, often painfully, that protecting home industriesand markets from competition does not work. It only leads to higher inflation, lower economic growth and domesticcompanies lacking the levels of efficiency and entrepreneurial skills ever to be internationally competitive. Otherstimuli to the globalisation of markets and competition have been faster and cheaper transportation and a continuingtelecommunications revolution that has made global communications cheap, simple and effective. Finally, the barriersto participation in world trade have often come down dramatically. Today any business can open an Internet website and market to customers from the other side of the world, just as easily as to its customers around the corner.

The result has been the emergence of new transnational companies organised to maximise the opportunities tobe gained from the new global market-place and to minimise the costs of serving it. Companies like Microsoft, GE,Intel, Merck, IBM, Starbucks and McDonald’s are selling in all the key markets. Their supply chains are equally global,with materials and components sourced from the cheapest locations, assembly and logistics organised from themost effective regional bases, and research and development located where relevant knowledge is most accessible.

In most sectors, small domestically-orientated companies lack the economies of scale to remain competitive overthe longer run. The scale economies of the transnational companies lie not so much in manufacturing costs but ininformation and knowledge. Focused transnationals like Intel, Apple, Dell and Cisco win out because they can affordto spend more on research and development, on building brands, on information technology and on marketing.Once new opportunities are identified they can also marshal the resources that are necessary to capitalise anddevelop the market.


CHANGING INDUSTRIAL STRUCTURES

The information age is changing the nature of the profit opportunities available to businesses. Many markets thatwere once at the very heart of the economy have ceased to offer profit opportunities for Western firms. Othernew markets are rapidly emerging that offer enormous profit opportunities to companies that can move fast anddecisively to capitalise on them.

Manufacturing industries can be divided into two types. One type comprises traditional industries such as textiles,coal mining, heavy chemicals, steel and auto manufacturing, which are relatively labour intensive and make heavy useof raw materials. These industries are relocating rapidly to the developing countries, which have a comparative costadvantage. Such industries also generally suffer the problem of substantial excess manufacturing capacity becausethese new countries have invested too aggressively in seeking to gain market shares. The result has been fallingprices and very poor returns on investment.

The second type of industries are the information- and knowledge-based ones such as pharmaceuticals, com-munications equipment, electronics and computers, aerospace and biotechnology. Here labour costs are typicallyless than five per cent of total costs. Most of the costs are information-related: research, design, development,testing, marketing, customer service and support. These are where the profit and growth opportunities occur forinformation-age companies. Contrary to the popular view, in most Western countries, manufacturing output hasnot declined in recent decades. What has changed is the switch away from traditional labour-intensive industries tothose that are information-based. Second, there has been a sharp decline in manufacturing employment – notablyblue-collar work, as these jobs have been automated or moved to the developing countries.

Overall employment has been maintained in information-age countries by the rapid growth of the service sector.Service-sector output has been growing at least twice as fast as manufacturing output in recent decades. In advancedcountries services now account for two-thirds of economic output. As living standards continue to rise consumersspend relatively more on services rather than on goods. Health, education, travel, financial services, entertainmentand restaurants are all growth markets. Informational technology has also become a massive service industry.Another reason why this will continue is that the output of information-based manufacturing industries is increasinglydistributed in service form. For example, pharmaceutical companies or book publishers, rather than exporting drugsor books, will license the rights to produce them. Many items such as music and news are already being downloadedfrom the Internet rather than bought in the form of a physical product such as a CD.

THE INFORMATION REVOLUTION

Rapid scientific and technological changes continue to radically reshape many industries. But the most dramaticand far-reaching changes of the current era result from the revolution in information technology. Initiated by thedevelopment of the mainframe and the personal computer in the 1960s and 1970s, its full implications only reallybecame apparent in the 1990s with the explosion in use of the Internet. By 2001, only a decade after the emergenceof the World Wide Web, a fundamental change in business and society had occurred – a critical mass of people,over 200 million, at home and at work, were able to communicate electronically with one another at essentially zerocost, using universal, open standards. By the end of 2007, that number had multiplied exponentially to over 1.3 billion.

The Internet, together with the emergence of broadband cellular radio networks, has created an explosion inconnectivity that is revolutionising almost every aspect of business. First, it changes the firm’s internal value chain – the


way people inside the business organise to design, produce, market, deliver and support its products and services.In the past, businesses had to organise through hierarchies and bureaucracy because information was expensive,difficult and slow to obtain. Today, intranets, which instantly and costlessly connect individuals within companiesfor the exchange of information, make obsolete the need for hierarchical functions. Instead cross-functional teamsand informal networking are encouraged, which in turn facilitate flatter, lower-cost organisational structures, fasterresponses and better customer service.

Second, the information revolution has changed the way the business works with its suppliers. Where partnershipsare important, information technology can make them much closer. Extranets, which connect companies to eachother, can seamlessly integrate buyer and seller into a virtual business. A typical example is the jeans maker, Levi.Over the Internet it continuously obtains information on the sizes and styles of its jeans being sold by its majorretailers. Levi then electronically orders more fabric for immediate delivery from the Milliken Company, its fabricsupplier. Milliken, in turn, relays an order for more fibre to Du Pont, its fibre supplier. In this way the partners takeout cost throughout the supply chain, minimise inventory holding and have up-to date information to enable themto respond quickly to changes in consumer demand.

In a similar way, when the bar code of a Procter & Gamble (P&G) product passes across a Wal-Mart scanner, thatinformation is immediately relayed to P&G, which invoices the retailer and makes another, which, in turn, is relayedto the distribution centre. This process has saved Wal-Mart millions of dollars in administration expenses.

On the other hand, where buyers see price as more important than partnerships, the widespread availability ofinformation undermines the suppliers’ relationships with customers. For example, component buyers can posttheir purchasing requirements on Internet bulletin boards and invite bids from anybody inclined to respond. Theinformation revolution has increased the information available to buyers and reduced the cost of switching suppliers.In general, the bargaining power of buyers has been radically increased.

Finally, the information revolution has significantly changed the nature of marketing and the marketing mix (see box,‘Traditional Marketing Meets the Information Revolution’). Traditionally buyers chose suppliers for both the qualitiesof the products and the information they supplied. For example, retailers like Toys ‘R’ Us or PC World prosperedby offering shoppers a wider selection of merchandise. But such formats are now undermined by search engineson the Internet, which can offer consumers much more choice than any store. This has created many new hugebusiness opportunities for companies able to exploit the informational advantage of the Internet. These includespecialist facilitators like Google which assist consumers in their search for information. Others have reconfiguredthe traditional industry chain to capitalise on electronic communications. Among the most successful in the late1990s was Amazon.com, which in only four years created the world’s biggest book retailing operation, and whichhad net sales of almost $15 billion by the end of 2007. Its business has broadened significantly beyond books, andincludes third parties selling a range of different products and services globally over the Net.

Traditional Marketing Meets the Information Revolution

For two centuries Encyclopaedia Britannica was one of the strongest and best-known brands in the world. Its largesales force successfully encouraged middle-class parents to view purchase of the 32-volume set of encyclopaediasas offering a genuine advantage for their children. Then the home computer and the CD-ROM came along. By theearly 1990s Britannica’s sales were collapsing.


What went wrong? First the emerging information age changed consumer behaviour. Now parents who wanted todo the right thing for their children bought them a computer rather than printed encyclopaedias. Once Microsoftand others launched CD-ROM versions of encyclopaedias, the game was lost. The cost of producing a CD-ROM wasabout £1; the cost of producing a printed set of encyclopaedias was around £250. The result was that Microsoft’sEncarta could sell at £50 or even be given away free; a set of Encyclopaedia Britannica sold at between £1300and £2200. Worse, because of its high cost, Britannica needed an expensive direct sales force to sell the product.The cheap CD-ROM versions were almost impulse items, which could be sold through computer shops or marketedto manufacturers for bundling with new computer sales. Finally, children liked computers and CD-ROMS more; aCD-ROM was easier and more fun to use than searching through a formidable set of 32 large books.

When the threat became obvious, Britannica brought out its own CD-ROM, but to avoid undercutting its sales force itcharged £755. Not surprisingly, its sales continued to decline. Finally, in 1997 the company recognised the issue, thesales force was disbanded and, under new ownership, the company sought to rebuild the business around the Internet.

The company now offers its extensive information in a variety of formats, including the original print versions,DVD packages, the online site, which also offers daily features, updates and links to news reports, and a mobileversion. However, its pre-eminence continues to be challenged by other online encyclopaedias, such as Encarta andWikipedia – even though the latter might seem to lack the authority of its older rival since it is written collaborativelyby volunteers within certain editorial rules.

Britannica’s real problem was that its management – like many others – failed to recognise the implications ofthe information era. The information revolution has made traditional strategies obsolete, destroyed barriers to entryand stimulated new competitors with dramatically lower cost structures and more effective marketing systems.Management recognised too late that its sales force had become an expensive liability and that the computerhad become the real competitor. The complacency of Britannica’s management is not unique. It is a predicamentthat a host of major companies have faced in such industries as cars, insurance, travel, financial services and majorsectors of retailing and distribution.

Contrast this with Yellow Pages – now called Yell – which didn’t make the same mistake as Britannica and wasin the forefront of putting its data into electronic formats alongside the more traditional print version. The result isthat Yell remains one of the top organisations in its sector.

Sources: Philip B. Evans and Thomas S. Wurster, Strategy and the new economics of information, Harvard BusinessReview, September/October, 1997, 70–83; The Economist, Encyclopaedias on CD-ROM, 17 February 1996,p. 67; New York Times, Start Writing the Eulogies for Printed Encyclopedias, 23 March 2008.

In many markets, information technology has led to disintermediation – the elimination of agents between thesupplier and the consumer. Buyers have found that they no longer need retailers, agents or brokers; they can buy atlower cost, and more conveniently, directly from the manufacturer over the telephone or, increasingly, the Internet.Companies like Dell in computers and Direct Line in insurance rapidly grew to market leadership by exploitingthis strategic window. When the seller deals directly with end consumers the opportunity is then created to builddatabases which record learning about individual consumer wants and buying behaviour. The seller can then createadded value by tailoring messages and even products for individual consumers. The information revolution hasthus begun to change marketing from mass communications and standardised brands to one-to-one customisedmarketing. For the innovators this has offered the opportunity for higher profit margins, greater loyalty and a biggershare of the customer’s spending.[4]


RISING CUSTOMER EXPECTATIONS

The information age has brought a marked rise in customer expectations. Buyers have grown to expect higherquality, competitive prices, and better and faster service. The most important causes have been the globalisation ofcompetition and the deregulation of markets. Once markets were opened up to today’s aggressive internationalcompetitors, companies that lacked a customer orientation or that had inefficient cost structures were soon introuble. The new wave of Japanese exporters such as Sony, Toyota and Matsushita in the 1960s showed Westerncompanies the new standards of quality required to stay competitive. Concepts like kaisen (continuous incrementalimprovement), Total Quality Management (TQM) and such schemes as the US Baldridge Awards and the EuropeanISO 9000 certification had real effects in raising quality standards. During the 1970s and 1980s major excesscapacity became a characteristic of more and more industries – for example, cars, steel, chemicals, electrical goods,agricultural products and banking. This further shifted the priority to gaining customer preference in hypercompetitivemarkets. Finally, the explosion of information technology gave management new tools for serving customers better:tools to continuously monitor customer needs and to improve the internal processes and supply chains that wouldenable them to meet, and indeed exceed, customer expectations.

Initially the response to meeting customer needs better was market segmentation. Companies brought out anincreasing number of product variants to meet the diverse needs of their customers. Nike had 347 types of runningshoe, Procter & Gamble had 207 brands and sizes of detergent, United Distillers introduced nine line extensions ofits Johnnie Walker brand of scotch whisky, credit card companies offered green, blue, gold and platinum versions,each with minor differences in the service offering, and so on. Media too became more segmented: mass-circulationnewspapers and magazines were replaced by a proliferating array of specialists. Digital technology also facilitated anexplosive growth in the number of radio and television channels.

The problem with market segmentation was that it was expensive and limited in effectiveness. More variants meanthigher manufacturing costs and spiralling inventory levels leading to lower profits and asset turnover. By 2000, theinformation revolution was beginning to offer a better alternative – mass customisation. Media and products couldbe tailored to the individual customer and made to order, using modern high technology communications andmanufacturing systems. Information technology allows companies to record all the information they obtain fromconsumers through their personal, written, telephone or Internet communications with the company. Creating adatabase allows companies to learn about the buying behaviour and preferences of customers and to communicateindividually and directly with them. Direct marketing creates the opportunity for a dialogue, allowing a precisespecification of the customer’s wants.

Dell Computer Corporation was one of the pioneers in showing how direct marketing could be allied to a fastresponse supply chain to produce customised products delivered to the customer’s door 48 hours after the order.[5]

For the customer one-to-one marketing offers a precise fit to his or her individual requirements. For the supplier itmeans higher margins and lower investment requirements.

STRATEGIC AND ORGANISATIONAL IMPLICATIONS

Companies survive only if they can adapt to this rapidly changing environment (Figure 1.3). This changing environmentdetermines what products and services customers will find attractive. It also determines the technologies that willbe available for companies to produce and market these products and services. By strategy we mean the business’s


ChangingEnvironment

Strategy Organisation

Figure 1.3 Adapting to a Changing Environment

overall plan for deploying resources to create a competitive advantage in its markets. Organisation refers to thecapabilities the firm possesses and how its staff are led, coordinated and motivated to implement the strategy.

Today the changes in the marketing environment are so momentous that they require radical strategic andorganisational change from virtually all companies. Gone are the days when managers could stick to tried and testedformulas to provide continuous growth and profitability. Globalisation, new industrial structures, rapidly changingtechnologies and new customer expectations are quickly eroding yesterday’s markets, while creating phenomenalnew opportunities for those that can move fast and decisively to capitalise on the changing environment.

Today five main issues stand out for management:

1. Participation strategy2. Marketing strategy3. Operations strategy4. Global strategy5. Organisational imperatives

PARTICIPATION STRATEGY

As the environment changes, the opportunities to achieve profitable growth change too. Some markets ceaseto have potential and should be exited; others offer great opportunities and require high investment, innovativestrategies and new organisations. Managers have to decide which markets to participate in. To do this they haveto objectively assess, first, the future attractiveness of the markets in which they operate. Because they differ inintensity of competition and price pressures from customers, some markets will become much more profitable thanothers. In general, the greatest opportunities are occurring in services, such as entertainment, education, softwareand mobile telecommunications. Other markets are extremely unlikely to generate returns for shareholders. Many


of the old labour- and raw-material intensive industries such as textiles, steel and heavy chemicals fall into thiscategory. Second, managers need to assess their competitive potential. With today’s fierce global competition, unlessa business can create a differential advantage, in terms of either low total cost or a superior product or service thatcan command a price premium from customers, it will not earn an adequate return.

MARKETING STRATEGY

The information revolution is making obsolete the marketing strategies of many traditional industry leaders. Itdestroys barriers to entry and transforms the structure of many industries. What is the role of a branch networkwhen customers can bank more conveniently on the web? Who needs retailers and distributors when you can selldirect to consumers? Every aspect of marketing comes up for renewal.

The customer and product mix needs to be strategically reappraised. The information revolution has increased theneed for firms to focus. Many firms have too many low-value customers who do not want long-term relationships.They also often have too many products bundled together by the classic informational logic of one-stop shopping. Butone-stop shopping loses its premium for customers once information is readily available. Specialists can then generallyoffer lower prices or superior service by focusing their operations around a single product or customer group.

Pricing strategies also need reviewing. The globalisation of markets, the euro currency and information technologyhave all made prices more transparent and comparable. Businesses not offering value to customers are seeingtheir market shares eroding at accelerating rates. The information revolution is having its most dramatic impacts onpromotion and distribution strategies. The company’s web site is increasingly becoming both the first port of callfor customers looking for information and a crucial source of knowledge about customers for the company. Morefundamentally, the Internet offers more and more companies of all sizes the opportunity to eliminate intermediariesand deal with consumers directly.

OPERATIONS STRATEGY

To implement a new marketing strategy requires the firm to create an operations strategy capable of delivering it.Companies need to construct a supply chain that can produce the right goods and services, at the right price, in theright place, at the right time. With today’s global competition and rising customer expectations, this right strategyusually means low prices, rapid delivery, reliable quality and up-to-date technology.

To meet these demanding expectations a new business model has emerged among today’s leading-edge companiesbuilt around coordination and focus. We will call this the direct business model (Figure 1.4). This model fundamentallyreshapes the firm’s downstream and upstream activities. Downstream the business model is built around bypassingthe dealer, selling direct to the customer and making to order. Generally the communications take place over thetelephone or, increasingly, the Internet. Selling direct has the crucial advantage of enabling the firm rather than theintermediary to control the relationship with the customer. Information from customers enables the firm to addvalue and develop loyalty by customising the offer and the communications to the customer’s exact requirements.Information also gives the firm leverage over its suppliers because it owns the brand and the customer relationships.The direct business model also cuts distribution costs, eliminates inventories and reduces risks by enabling betterforecasting of consumer demand.


Traditional model: value chain with transactions between independent parties

Direct business model: eliminates distributors

Virtual integration: develops direct model further by using IT to integrate supply chain partners and customers

Suppliers

Suppliers

Upstream Downstream

Manufacturer

Manufacturer

Distributionchannels

Customers

Customers

Suppliers Manufacturer Customers

Figure 1.4 The Evolution of a New Business Model

Upstream the model is built around close cooperation with suppliers. Manufacturing and logistics is outsourcedto a carefully selected set of partners. These suppliers are linked electronically to the firm and treated like aninternal department. Instead of vertical integration – control and coordination through ownership – we have virtualintegration – control and coordination through information. This reduces the assets required to support rapidgrowth, minimises financial risk and maximises flexibility. It frees the management to focus on what adds most valuetoday – delivering solutions and systems to customers. The direct business model creates genuine value throughcustomer focus, supplier partnerships, mass customisation and just-in-time manufacturing.

GLOBAL STRATEGY

In today’s connected world, every company now needs a global strategy. Industries are globalising at a rush andcompanies that are not leading, or at least participating, in the new alliances, are becoming non-viable. Manufacturingtended to globalise first but now services are following rapidly. For example, a series of mega-mergers in the 1990sglobalised accounting, financial services and most of the advertising industry into a small number of huge globalgroups. Regional and global groupings have also emerged in telecommunications, banking, contract services andmany other areas.

In business-to-business markets – to which most companies belong – the pressure to globalise comes from theircustomers, which operate across the world. Procter & Gamble and IBM want suppliers and business partners thatcan interface with their own far-flung geographical operations. The opportunity to spread the costs and lever theinvestments in research, development and technology also favours global players. Finally, being dependent on a singlecountry market leaves today’s local player highly vulnerable. Strategically it is in a weak position to counter-attack


against a strong global player moving into its market and being willing to cross-subsidise its entry from profits earnedin other markets.

As in most areas of business today, there are big advantages in speed and decisiveness when it comes to globalstrategy. The longer management prevaricates, the fewer the options are available and the higher the price thathas to be paid.

ORGANISATIONAL IMPERATIVES

To implement new strategies requires new organisations. What is different about organisations in the informationage? First, employees are different. Blue-collar workers have given way to knowledge professionals. Part-timers andwomen make up an increasing proportion of the staff. The skills of the new knowledge workers make them lessdependent on the company and more mobile. Motivating them requires different work environments and incentivesfrom the past. Second, information and communications technology now permits new and more effective ways forpeople within the firm to relate to one another and to relate to others in the supply chain.

Finally, the new strategies ushered in by the information age require different responses from staff. A customerorientation becomes more important since more of the staff are now directly involved in providing customer serviceand customising products and solutions. The priority consumers now give to convenience and speed of responsedemands much greater empowerment and commitment from staff. The pressure on prices and the need to providegreater shareholder value also drive management to seek higher productivity and better utilisation of assets.

The direction of organisational changes is clear. Delayering has been one major move. Information technologyhas enabled companies to reduce the number of levels of middle management, providing for greater customerorientation, lower costs and faster response. Second, enhanced connectivity is breaking down functional barrierswithin firms, permitting a much greater use of cross-functional teams, which again makes for faster response andgreater customer focus. The same forces have increased the flow of information between firms, facilitating moreeffective networks to lever the firm’s capabilities with those of its business partners. The final change has beena greater focus on shareholder value. Investors are putting much more pressures on managers either to deliversuperior returns or return the cash to shareholders.

The implications of the changing environment for strategy and organisation – and hence for the firm’s ability toachieve longer term growth and profitability – can be summarised in five principles:

1. Strategy must fit the environment. Companies can remain competitive only when they have products andservices which today’s customers regard as offering superior value. Perceived value is shaped by the changingmacro- and microenvironments within which the firm and its customers operate.

2. Successful strategies erode. Winning formulas eventually lose out because the environment changes.Competitors copy successful products and processes. Changing tastes and new technologies make yesterday’ssuccesses obsolete.

3. Effectiveness is more important than efficiency. Old formulas cannot be preserved by downsizing andcost reduction. Innovative solutions have a way of coming down in costs to offer superior value across alldimensions of value. Success in the information age is about renewal rather than retrenchment.

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